Living Large

W hat does it take to be rich in America today? Some people figure you're rich if you're making noticeably more money than they are. Certain politicians will say you're rich if you merely inhabit the income level where Republicans start to outnumber Democrats. Being a millionaire was once upon a time more than enough to qualify, but today even if you have $1 million, a lot of wealthy folks consider you merely middle class, albeit upper middle class.

The dictionary defines rich as "having an abundance of money." The Commerce Department, that great repository of economic factoids, doesn't even utter the R word, although it does classify people as "affluent" once they make $75,000 a year. Tell that to anybody who's supporting a family in New York or California on $75,000, and you're likely to hear a sardonic laugh.

Some people are clearly, unquestionably, rich. Multibillionaires like Warren Buffett, Bill Gates and Ron Perelman come to mind. These folks are different from you and me, or at least their spending habits are. Microsoft cofounder Paul Allen, for example, satisfied his basketball fantasies by buying an NBA team and having them practice in his home gym.

Surely, a lot of Americans qualify as rich even though they are well short of billionairehood. But at what point can it be agreed that a person has, for the first time, actually "made it"? When can it be said his start-up business or his stock options or his investment portfolio has carried him across the line from being merely affluent?

The first thing to be considered is the attribute of wealth that was identified as the most important by the late Malcolm Forbes, who had some experience in these matters. "True wealth gives you freedom," he used to say. Indeed, what does it matter if you're making a quarter of a million dollars a year or more if you can't afford to quit? You're still a wage slave, however gilded the cage may be. That's why living well on your employment income matters a lot, but being able to live on your assets matters even more.

High living and lush incomes are the common image of wealth. Hard assets are the real measure. That's why we have chosen to count someone as rich only if he or she can live very well on the return from invested assets. In other words, you are rich if you could chuck it all, if you so chose, and live reasonably happily ever after. Of course, deciding whether you have enough is a deeply personal decision. Some people are happy to live on nuts and berries in a Vermont log cabin. And even among the rich, there are varying degrees of wealth. With that in mind, we have established four distinct levels of wealth: Beer & Pretzels Rich, Filet Mignon & Champagne Rich, Yacht & Limousine Rich and, lastly, Really, Really Rich.

To simplify matters, we're going to make the assumption that our would-be rich man or woman has life's typical financial obligations well under control. If there is a private business, we assume that its debts are held by a corporate entity. We also assume that the principal residence is paid for or nearly so, the kids' education is finished or approaching completion, and any ex-spouses are not in the picture -- financially, at least. If you have any such obligations, you'll need an offsetting amount of additional wealth before you can consider yourself rich. With that caveat, let us begin.

Beer and Pretzels

A s noted, Beer & Pretzels is our threshold level of wealth. It is obviously hard to say just where middle class ends and upper class begins, but statisticians generally put a lot of store in the 95th percentile as a measure of high significance: If you're in the top 5% of something, it's pretty clear you're doing well. So we will reckon that the borders of the rich man's world start there. The most recent figures available from the IRS indicate that individual taxpayers in the 95th percentile earn $98,221 a year in adjusted gross income. In all, 5.9 million filers showed that much or more adjusted gross income in 1995. That's based on a total of 117.3 million total individual filers that year.

On that kind of income you can live a pretty good version of the middle-class existence, especially with the mortgage on your principal residence paid off. You can expect to have recent-model cars in the garage, take trips when you like, own a decent vacation place, a boat if you want. Even after paying federal and state income taxes, you've probably got something in excess of $6,000 a month to maintain your lifestyle. And you may have a bit more than that to spend if you have ample deductions and live in a state with low or no income taxes.

The cost of the good life also varies from city to city. To take that into account we've compiled a table , showing that you need slightly more assets to qualify for the good life in expensive cities like New York and San Fransisco than you would in smaller places like St. Louis or Tampa. The city that came in with the average cost of living is Cleveland, with others arrayed above and below it.

Wherever you reside, you can live reasonably well on about $98,000 a year. The basics should be well taken care of, with some goodies thrown in. Though you may still have to budget a bit, you're not cutting corners.

If this doesn't sound like the lifestyles of the rich and famous, think for a moment. Remember that critically important benefit of having wealth: freedom. With annual income of $98,000, our successful striver can live as well as or better than the vast majority of people do, and far better than nearly everyone in previous generations has lived in all recorded history. And best of all, he's no longer tied to a job: no boss or board to report to. Of course, our rich man or woman may choose to continue working. Most people probably will if they can. But the point is, they have the freedom to choose.

Clearly, if someone can get $98,000 a year from their investment assets, without drawing down the principal, they are well off. They shouldn't want for much of anything unless they've somehow become addicted to Impressionist paintings or private jets.

To sustain this Beer & Pretzels level of wealth, we calculate that one should have investment assets of $2 million, plus a paid-off house appropriate to this income level, probably something with a price tag of about $500,000.

Filet Mignon & Champagne

T o get to the level of being Filet Mignon & Champagne Rich, we've decided that your annual income must be in the 99th percentile. To qualify, you must have adjusted gross income of $209,406. A mere 1.2 million people filed this much or more on their tax returns in 1995.

When you've reached this level of wealth, you're rich enough to have a tax problem, and if you're investing in Treasuries but not munis, you're getting bad advice. You can certainly drive a Jaguar if that's what you like, while your spouse tools around in the latest Mercedes. The Robb Report has replaced Consumer Reports on your coffee table. Your house is probably worth about $1 million. Your vacation home, if you want one, can be very respectable. In short, everything can be absolutely first class, unless you're really into being thrifty. It's important to point out here that a lot of wealthy people are quite thrifty, as noted in the recent bestseller The Millionaire Next Door .

To make the Filet Mignon & Champagne benchmark, you need investment assets of about $4.2 million, plus a suitable, paid-off house.

If you've made this mark, congratulations. But we have to tell you, you're not yet seriously rich. To get to that level, you'll have to jump considerably higher.

Yacht and Limousine

W here should the next line of demarcation be drawn? Suppose you were really in the catbird seat, careerwise. If you don't set your own salary, the people who do are on very good terms with you. They may actually be in their positions at your behest. There is plenty of money around to pay you very, very well. All you could want. Suppose two of the main inhibiting factors in naming your salary were what others in your happy position were getting and the point where your annual salary gets so big it looks embarrassing. You'd choose to be as rich as you want to be, wouldn't you?

Well, there are people in this wonderful situation, and there is considerable evidence that many of them are not overly bashful about being paid accordingly. They are, of course, the chief executive officers of America's largest public corporations, and in such a position they certainly shouldn't want to be looked down upon by anyone, even when they're away from the office. Barron's will go with their collective and surely well-informed estimation of what it takes to live the really good life. We have taken for this standard the median salary of the CEOs of the companies in the Barron's 50-Stock Average, which includes such varied institutions as
AT&T
,
BankAmerica
,
General Electric
,
Mobil
,
Sara Lee
and
Wisconsin Energy
.

Last year the median salary of the 50 Barron's CEOs, before stock options and bonuses, was $895,000. At these rarefied levels, you've arrived by just about any standard. No one is sure how many Americans have precisely this level of income, but the IRS says that in 1995 about 87,000 individuals reported adjusted gross incomes of $1 million or more. That amounts to about one out of every 1,350 filers.

With an income of $895,000, you can swing a half-million-dollar vacation home and a million-dollar yacht, or the other way around. You can write annual six-figure checks and be on the boards of the more prestigious local cultural centers or philanthropies, which will qualify you as a Very Big Wheel. Your alma mater will be besieging you. A limousine? The Fugazy limousine service in New York will provide car-and-driver service contracts based on a rate of $45 an hour, before gratuities. If you log a typical 10,000-20,000 miles a year, you could get by for $35,000 or less. This saves you the hassle of having to hire a full-time chauffeur.

Being Yacht & Limousine Rich should be permanently sustainable on investment assets of $17.9 million.

Suitable digs? Almost anything you want. An estate costing $5 million could be financed, though such buyers normally finance with margin loans on their investment accounts, or by borrowing from their company, or by liquidating assets, according to Craig Atkinson, an experienced financial-services officer at Sterling Capital in the New York suburb of Stamford, Connecticut.

Really, Really Rich?

H ow do you qualify as Really, Really Rich? Well, even the country's top CEOs have wish lists. And remember, that $895,000 is just straight salary. They get bonuses of every kind, to get them to where they'd like to be, or to build an estate, or to be "properly incentivized," or just because. For our 50 top CEOs, the median pay package last year, including bonuses and stock options at present value, was $1,921,000. That is as far as they push things currently, and so that's as far as we go with our income target.

The investment portfolio currently needed to sustain this annual income level amounts to $38.5 million. On this, you can do all the yacht and limousine stuff mentioned above, and much more. Even with lousy tax advice, you'd have more than $1 million a year to play with. With capital gains and smart use of municipal bonds, you'd have a good deal more.

Go ahead, subsidize that horse farm you've always wanted, it'll probably reduce your taxes. You can be a serious bidder at Sotheby's, too, even if you do have to let the Getty Museum take the really good pieces.

What size house is appropriate to your station in life? On this income, New York's Chase Manhattan Bank would grant a $5 million mortgage for an $8 million property, if anybody asked. Actually, it is more common for people in this category to own several homes, each in the $1-$2 million range.

Does anyone need a category beyond Really, Really Rich? Well, a net worth of $50 million has taken on a certain cachet these days. From that, we calculate you could draw $2,546,940 in income a year.

Near the peak of our wealth barometer is the old Forbes 400. The threshold fortune in last year's edition was $475 million, which could yield $23.7 million a year in income indefinitely, if properly managed. At the pinnacle is the club of billionaires. Nationwide, there were just 170 of these.

But who needs all that? It seems to us that a person ought to be able to live sensibly with assets of $38 million and an annual income of $2 million or so a year, even if that is before taxes.

Playing the Market, Cautiously

Once you've amassed your nest egg, how should you invest it? We put that question to the pros at some of the most respected money-management companies in the U.S. Broadly speaking, they tend to agree on certain principles. To begin with, anywhere from two-thirds to three-quarters of the loot should be invested in common stocks. As we all know, stocks can fluctuate violently in the short term, but over the long term, equities give the best overall return.

"We often have to spend a lot of time persuading new clients to diversify enough into stocks," says Leo Grohowski, managing director of the Bankers Trust portfolio management group.

Our various advisers suggested that stockholdings should be diversified as follows: mostly big high-quality U.S. companies, plus varying amounts of small to medium-sized firms, and some foreign stocks, split between developed nations and emerging ones.

Another key holding is municipal bonds, which offer interest payments that are shielded from federal, state and local taxes. Generally, munis tend to be safe and stable, and they account for 30% of our model portfolio.

Smaller amounts can be invested in so-called alternative investments like venture capital, hedge funds and real estate. Our experts recommend that people in our Beer & Pretzels category avoid such investments entirely, while those in the upper brackets may devote as much as 5% of their portfolio to alternative investments, if they are so inclined.

A year's living expenses should be kept in cash holdings, just to buffer against short-term lunges in the markets.

When figuring your annual payout, our private bankers unanimously agreed that people living off their portfolio should use the total return on the portfolio, capital gains included, rather than just the stock dividends and bond yields alone. "Yields today are just too low," says Grohowski. "We'd rather have clients invade principal, provided it's at a rate significantly less than the anticipated growth of the portfolio."

The advisers we consulted all felt that an annual draw of up to 5% or 6% of a portfolio is currently safe and consistent with long-term growth. That said, the less you draw, the safer you are.

None of our advisers count on the inflation rate always remaining as low as it is today. "We use a working figure of 3.5%," says Grohowski. This figure, being somewhat higher than the real inflation rate of 1.6%, allows for an unexpected uptick in the inflation rate and provides a cushion against any other unforeseen hazards.

In putting together the nearby portfolio, we've added a wrinkle of our own: Instead of investments in emerging countries and illiquid investments, we are substituting a more conservative choice, using the recent return on Dow Jones' Equity Real Estate Investment Trust Index. This gives a nod to a widely used investment class that private bankers tend not to focus on, namely, real estate.

To figure out expected returns, we took the historical return on each type of investment in our portfolio and then multiplied that by the percentage of our portfolio that is dedicated to that asset class. Thus, for large-cap stocks, we took the 11.06% long-term annual return on the Standard & Poor's 500 and multiplied that by the 35% of our portfolio dedicated to large-cap stocks.

In total, we came up with an annual expected portfolio return of 8.5%, then subtracted a generous 3.5 percentage points for inflation and other financial hazards, and arrived at a prudent annual draw of 5%. Using this rate, we were able to determine the asset levels needed to qualify for the four stages of wealth set out in the accompanying story.

Executive Decisions

A lot of corporate executives draw salaries that allow them to live well, but many of them, particularly the younger ones, have not yet accumulated enough assets to consider themselves wealthy. To a great degree, the size of their personal fortune will depend on how they fare in the corporate world, how they manage their money, and how they navigate through their individual maze of options and stock grants.

If you're a rising young star, don't count on leaving too early. "Most executive compensation plans have restricted stock that requires you to retire at 55 or later, and then often only with the permission of the company," says Chris Flanagan, a senior vice president at Mellon Bank.

As for stock options, which generally have a 10-year life, the rule of thumb is to exercise them in their seventh year, Flanagan explains. It's true that the stock could rise during the last three years of the option, but it also could fall, and precipitously. As you get closer to exercise date, you're taking on increasing market-cycle risk, which Flanagan advises against. As he puts it, "Being a market timer is a bankrupt idea."

Executives who get grants of restricted stock, which usually can't be sold for a number of years, are well advised to pay taxes on them up front, Flanagan says. "You get the option of either paying the tax now, or waiting three years until it all vests and the restriction lifts," he explains. "Pay the tax right away when you're awarded the stock. Then appreciation will get capital-gains treatment."

He also reminds executives that any bonds that aren't municipal bonds should be bought only for tax-deferred accounts, such as 401(k)s, traditional IRAs and the like. By contrast, one of the key advantages of holding stocks in taxable accounts is that any stock losses can be used to reduce the taxes you owe on your winners. The other advantage, of course, is that winning stocks held in taxable accounts qualify for treatment at the capital-gains rate, which is lower than the rate for ordinary income.

An additional bit of advice for everybody: Keep adjusting your portfolio to maintain your ideal mix. "Say you had decided a blend of 75% stocks and 25% bonds was appropriate for you. A few years have gone by, and with this market you're probably at least 85%-15% by now." Flanagan says. "People have been ignoring this because of the roaring bull market, but if 75-25 was right for you then, it probably is now. You should wring the added risk out of your portfolio."

Flanagan's employer, Mellon Bank, was originally the primary vehicle for managing the Mellon family's vast fortune. Since then, of course, it has evolved into a major factor in managing money for wealthy individuals. It now has $80 billion in accounts of all kinds under management. "Today 85% of our millionaires are self-made, just the reverse of what it was 20 years ago when I started in this business," says Flanagan.

Flanagan is one banker who counsels conservatism. For one thing, he remains skeptical about what he calls "the belief in the New Era -- the idea that Greenspan can manipulate continual prosperity out of the economy." He warns clients, "If you're not careful, you may not have as much as you think you have."

Doctor's Tale

If you're not persuaded financial independence is the true measure of wealth, consider this example of how the world can change unexpectedly for anyone. "Being a doctor was one of the most secure and satisfying professions around," says an established specialty surgeon in an upscale suburb of New York. "But now almost everything goes through an HMO or PPO, and the decisions are being made over your head by people who never practiced medicine, sometimes just a clerk reading from a company form."

There's also the money. "Everybody I know has seen their revenues fall 40%50%, and their office costs keep going up. This is all on top of the malpractice hassle. And there's the problem of getting insurance companies to actually pay what's due. They stall, they hang up on you, they 'lose' records. Last year, for the first time I can remember, I heard of a doctor filing for bankruptcy, and I actually know of doctors who are pushing Amway, or Rexall vitamins, to supplement their income.

"I think you'd see more doctors leaving medicine, but they're like me. I've put three kids through college and have two more to go, so I've put almost nothing into my pension plan. Like everybody, I figured I could get around to that. Then everything changed in the last several years, and that pulled the rug out from under us.

"I feel I'm lucky. I foresaw this early and could do something about it."

What's he done? He's helped start a telecom company on the side. "In about a year and a half, I expect to walk out, padlock the office door behind me, and never look back. I think I'll be okay. Other people won't be so lucky. Lots of guys don't know anything but medicine, and now don't have the money they thought they would have to fund their retirement."

--H.S.

Harold Seneker , who launched the Forbes 400 list and managed it for more than a decade, is an editorial consultant based in Fair Lawn, New Jersey.

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